construction by ROcq7NRA

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     Welcome and Introductions

                 Welcome to the Construction
                      Auditor Seminar

        Objectives of the Seminar

   Seminar will focus on the ―cradle to grave‖
    approach to audit construction projects and
    related activities.
   Focus will be on the entire life cycle of a
    construction project.
   We will review Why, When and How to audit a
    construction project.
   Seminar will cover 13 Units.

                             Unit One
                 “Why Audit Construction Contracts”
  • Capital construction projects can create significant
    exposure for organizations that are unaware of the risks
    associated with excessive cost, project delay and quality
    issues. We will review the principal reasons for auditing
    construction projects and the benefits that can be
    derived which will serve as the platform for the learning
    objectives of the course.
                  Reasons for Auditing
                 Construction Contracts
  • Projects are costly, many opportunities for
  • Recommend controls
  • Enhance cost/schedule performance and
    reduce scope creep
  • Protect employees
  • Reinforce project governance
  • Assist in mitigating risk
  • Assess impact to operating budget
                 Risks and Controls
  • Financial Risk
  • Construction Risk
  • Compliance and Safety
        Why Audit Construction
  • Top management is concerned and exposed
  • Projects are costly and subject to overcharges
  • Identify opportunities for cost savings and/or cost
  • Provide independent verification of payments
  • Delays can result in lost market opportunity and
        Why Audit Construction
          Projects (cont 2)
  • Important assessment of the effectiveness of
    internal control
  • Recommend controls to prevent potential
  • Reinforce integrity of contractors
  • Helps keep project on track
  • Protects employees
        Why Audit Construction
          Projects (cont 2)
  • Reduces reputational risk
  • Minimize disputes and litigation with
  • Assess impact to operating budget
  • Valuable tool for lessons learned
                       Unit Two
                   “Key Stakeholders”
  • There are a number of key stakeholders involved in
    construction projects. Each has a specific role and
    responsibility related to construction activities and/or
    the governance and oversight process. An integral part
    of the audit process is to assess whether each
    stakeholder has met their responsibility and mitigated
    the risk that is inherent in construction projects.
                 Key Stakeholders
  The Internal Project Management Team:
  • Owner – Responsible for the Scope, Cost,
    Quality, and Safety of the Project
  • Construction Management/Engineering –
    Design, Scheduling, Construction Monitoring
  • Budget – Financing and Budget Control
  • Procurement – Bid and Selection Process and
    Contract Administration
                 Key Stakeholders
  • Legal – Contract Terms and Conditions
  • Controller/Accounts Payable – Pays
    approved invoices
  • Risk Management – Insurance, Bonding
    & Safety
  • Internal Audit – Monitoring and
      Key Stakeholders (cont)
  External Project Team (depends on
    delivery method):
  • Construction Manager – Agent of the
  • Architect/Engineers – Designs Project
  • General Contractor – Prime Builder
  • Sub-contractors - Specialist
  • Suppliers – Material & Equipment
                          Unit Three
                  “The Construction Life Cycle”
  • There are four (4) major stages in the
    life cycle of a construction process. This
    module will discuss the components of
    each phase and touch on the possible
    risks in each phase.
            The Construction Life
  • There are four major stages :
        –   Planning /Program & Design
        –   Bid/Procurement
        –   Construction
        –   Close-Out
         1. Planning and Design
  • Planning and Feasibility Study
  • Design
  • Contract Document Development
  •    Inadequate Scope
  •    Incomplete data
  •    Poor estimating
  •    Lack of details in building model
  •    Over design
  • Project manager should review and approve
    design documents to confirm consistency with
    project objectives
  • Evaluate bid packages to confirm materials are
    consistent and complete
  • Have an independent constructability review
        2. Bid and Procurement
  • Construction Bidding
  • Bid Solicitation
  •    Lack of competition
  •    Incomplete bid documents
  •    Timing
  •    Fraud
  • Review process used or followed to
    solicit, receive and review bids
  • Review contractor pre-qualification
  • Review contract award process
           3. Construction Phase
  • Divided into two stages:
        – Project mobilization
        – Construction
  •    Delays
  •    Cost overruns and numerous change orders
  •    Quality issues
  •    Financial exposure due to unsafe work conditions
  •    Regulatory, financial and reputational exposure due to
       adverse environmental impacts
  •    Cost accounting and project tracking system
  •    Robust change order review and approval process
  •    Monitoring of quality and quantity of work
  •    Safety audits
  •    Processes and procedures to monitor, record and
       account for environmental compliance
  4. Project Close-out Phase
  • Also divided into two stages:
        – Completion of work that must be done at
          work site
           • Substantial completion, final punch list,
             cleanup, testing, start up of mechanical
             and electrical systems, etc
        – Providing all required documents
           • As built drawings, manuals, warranties,
             certification of completion, etc
  • Claims made by the contractor for additional cost or
    work not included in the contract and/or by change
  • Liquidated damages—claims made by the owner against
    the contractor for the failure to complete the project by
    the established date
  • Adequacy of the final testing of the mechanical and
    electrical systems
                 Risks (cont)
  • Resolution of items included on the punch list
  • Payment to subcontractors and suppliers
  • Closeout audit of billings and payments
  • Audit of claims and assessment of liquidated
  • Confirmation of the receipt of final deliverables
  • Verification of acceptance testing and
                                   Unit Four
                    “Types of Construction Contracts and
                 Construction Project Delivery Methodologies”
  • There are several different types of
    contracts and delivery methods that can
    be used in construction
    projects/activities. We will discuss the
    risks and benefits of each type. This will
    serve as the basis for the following
    modules on deciding what types of
    projects to audit.
           Types of Construction
  •    Fixed Price or Lump Sum
  •    Unit Priced
  •    Guaranteed Maximum Price
  •    Cost Plus/Cost Reimbursable/ CPFF
  •    Time and Materials
             Type of Contract and
               Associated Risk
  Fixed Price/ Lump Sum
  • Contractor assumes all Risk
  • May attempt to minimize risk if actual
    cost exceeds bid price
  • Poor Quality or Inferior Materials
           Types of Contract and
              Associated Risk
 Cost Plus/Cost Reimbursable Contract
 • Owner Assumes Risk
 • Contractor has little incentive to control
 • Contract should have a GMP
             Delivery Methods (1)
  • Design-Bid-Build


                    General Contractor

      Three Sequential Phases
  • Design Phase
        – Owner hires team of architects and engineers to build
          plans and specs used to solicit bids
  • Bid Phase
        – ―open process‖-any qualified bidder
        – ―select process‖-limited number of pre-selected bidders
  • Construction Phase
        – Winning contractor becomes General Contractor
        – General Contractor hires sub-contractors
                 Benefits to owner
  •    Process well understood
  •    Design Team impartial
  •    Complete set of documents up front
  •    Same set of documents to all
  •    Ensures fairness to bidders
  •    Assists in reasonable prices
  •    Uses competition
                 Risks to owner
  • Failure of design team to be current with construction
  • Potential cost increases
  • Lowest bidder may be undesirable
  • GC’s bidding may include low bidder
  • No up front input from GC
  • Potential adversarial relationship between designer and
  • Final costs unknown until bids are finalized
             Delivery Methods (2)
  • Design-Build

                    General Contractor/Joint Venture

                    Architect            Sub-contractors

  • Design and construction by single entity
  • Used to minimize project risk to owner
  • Reduced delivery schedule
                 Benefits to owner
  • Saves time
  • Early agreement on cost and schedule
  • Less ―finger pointing‖
  • Reduces change order liability to owner
                 Risks to owner
  •    Fast track eliminates integrated design
  •    Must have right team
  •    Potential loss of control of project
  •    Decisions by builder may lead to
       dissatisfaction and adversarial
             Delivery Methods (3)
  • Construction Management

                 Construction Manager

                                 Prime/Multiple prime contractors

                                        Trade contractors
  Owner hires, under two separate
        – Architect to design the project
        – Construction Professional-‖Construction Manager‖
          (CM) who works with design team to ensure design
          can be built for reasonable cost, and that contractor
          can understand drawings and specs
           Construction Manager
  • Generally does not perform construction work
  • Is an agent of the owner
  • May be engaged in lieu or in addition to general
  • Engaged as either:
     – (a)―Agency Construction Manager‖
     – (b)―Construction Manager at Risk‖
      (a) Agency Construction
  • CM acts as an agent or consultant to the owner-
    fiduciary capacity
  • CM has no legal responsibility for actual construction
  • Has no prime or sub-contractors
  • Manages general contractor or multi-trade contractors
  • Offers advice without potential conflicts of interest
   (b) Construction Manager
  • Acts as a General Contractor
  • Assumes responsibility and liability for
    construction work
  • Responsible for means, methods, and
    sequence of construction
  • Has ultimate authority over the trade
                       Unit Five
                    “Audit Planning”
  • We will review the process for selecting
    which construction project or
    construction activity to audit and why.
               What Drives a
            Construction Project?
  • Schedule/Time
  • Cost
  • Quality
       How Should Projects Be
         Selected For Audit
  •    Size
  •    High Profile/High Risk
  •    Fast-Track Schedule
  •    Complex Contract Terms
  •    Type of Contract
  •    Experience of Owner Representative
  •    Experience of General Contractor
            When Should Construction
              Projects be Audited?

  •    Begin at the Planning and Design
  •    Contracting Stage
  •    During the Construction Period
  •    Project Close-out
        Goals and Objectives of
          Construction Audit
  • Safeguard owner’s interest
  • Confirm you got what you paid for
  • Identify cost avoidance opportunities
  • Identify overcharges and/or undercharges
  • Ensure appropriate owner and contractor controls in
  • Avoid litigation
  • Mitigate risk
                 Keys to Success
  •    Appropriateness of project
  •    Effective and thorough planning
  •    Selection of delivery method
  •    Robust contracts
  •    Addressing project risk
  •    Accessing project controls
  •    Effective ongoing monitoring
  •    Controlling cost
  •    Qualified personnel
                 Things to Remember
  • All types of contracts can be audited
  • All construction projects could be audited to
    reinforce a level of comfort
  • Contracts should include a ―right to audit‖
  • Audit should be of both the Prime and
  • Need for properly skilled auditors
  • Consider assigning auditors to the
    construction site
                              Unit Eight
                 “Construction Life Cycle-Construction
  • In this module we will review some of
    the risks and exposures (delays, change
    orders, claims, contractor billings,
    progress payments, quality issues, use
    of approved contractors, etc.) during
    this phase of the process and develop
    audit objectives and strategies
                       Audit Focus
  • Typically will include:
        –   Contract review
        –   Cost accounting and project scheduling
        –   Verification of quantity and quality of materials
        –   Subcontractor approval process
        –   Change order process
        –   Billing tests
     Lump Sum or Fixed Price
  • Remember characteristics:
        – Contractor is paid pre-agreed fixed amount
          irrespective of actual cost
        – Contractor assumes all the risk that project will be
          completed for less than fixed price-profit; if more,
          contract or loses money
  • Risk
        – Contractor tries to ―cut corners‖ by not adhering to
          all requirements of contract
     Lump Sum or Fixed Price
        Contract (cont)
  • Audit considerations
        – Prepare cost control schedule
        – Review pricing schedule and reconcile summary of
        – Look for duplicate payments or overpayments due to
          change orders
        – Confirm contractor has appropriate and adequate
          insurance and bonding
        – Verify change order process has been followed and priced
          in accordance with the contract
        – Others
                 Cost Plus Fee Type
  • Remember Characteristics-
        – Guaranteed Maximum Price/Cost
        – Cost of project to owner consists of all
          direct costs-labor, materials, equipment-
          plus overhead and profit
        – All costs must be incurred/invoiced before
      Overall Audit Strategy &
  • Perform billing tests of contractor’s progress
  • Tests will include:
        –   Labor
        –   Material
        –   Overhead
        –   Contractor fee
        –   Field and Home Office charges
        –   Subcontractor charges,
        –   Etc
      Overall Audit Strategy &
           Focus (cont)
  • Must be thoroughly familiar with contract
    terms and allowable vs unallowable expenses
        – Prepare cost control schedule
        – Review pricing schedule and reconcile summary of
          payments made to contractor
        – Prepare a breakdown of payments by major cost
          elements. Look for duplicate or overpayments
                  (1) Direct Labor
  •    Audit Objective
        – ensure all costs related to direct labor are reimbursable, have
          occurred, and are billed as actual costs as defined in the contract.
  •    Audit Procedures
        – Review contractor’s payroll and certified payroll information to
          verify billed wages agree with wages paid
        – Review employee time sheets and reconcile to certified payroll to
          verify hours billed
        – Review union agreements to verify that proper rates were billed
        – Compare payroll information to ensure that the employees are
          not be charged by both the prime and subcontractor
        – Trace payments to canceled checks
        – Conduct a payroll distribution
                 (2) Labor Burden
  •    Audit Objective
        – Same as Direct Labor
  •    Audit Procedures
        – Review contractor’s charges for payroll taxes, fringe benefits and
          insurance, FICA, Federal and State Unemployment taxes,
          Worker’s Compensation
        – Confirm that accurate rates were used and that employee payroll
          limits were not exceeded
        – Review union agreements to determine the accuracy of charges
          for union benefits
        – Verify that employees being charged for benefits are eligible to
          receive benefits and that they were actually receiving the benefit.
                 Common Audit
• Incorrect hours charged to project
• Unauthorized or excess employees charged to
• Unauthorized/unnecessary overtime
• Workers Comp- contractor does not pay at rate
• Inflated burden rates
• Taxes continued to be charged after payroll limits
  are reached
         (3) Material Purchases
  •    Audit Objective
        – Same as Direct Labor but also verify materials purchased
          were not of a lesser quality and for quantities not specified
          in contract
  •    Audit Procedures
        – Compare quantities installed with contract drawings and
          specifications, follow up on significant differences
        – Confirm competitive quotes used and reasonable purchase prices
        – Compare invoices from suppliers for compliance with contract
          prices and if any discounts were received
        – Reconcile total quantities purchased, with amounts delivered and
        – Check to see that the owner gets credited for returned or unused
                 Common Audit
  • Materials billed but not used at site/used at
    another site
  • Materials of a lesser quality than required
  • Overstated quantities delivered to site
  • Failure to receive discounts
  • Failure to use competitive process to procure
  • Insufficient documentation to support amounts
            (4) Equipment Rental
  • A variety of equipment required for projects. Equipment
    can be contractor owned, leased from a third party or
    job owned—purchased and charged to the job
  • Audit Objective
        – Same as Direct Labor but also, if equipment is job
          owned, verify that owner receives credit for all
          equipment purchased and charged to the job
            (4) Equipment Rental
        – Contractor owned and third party rental usually billed on
          time used and rate per hour of use
  • Audit Procedures
        – Review contract for rates to be charged and basis for rate
        – Confirm that multiple quotes were received
        – Analyze and confirm rates charged are in agreement with
        – Review daily job reports and time sheets of machine
          operators to determine equipment usage
        – Contact vendor if different leasing options were available
          and that the most cost effective was in use
        – Determine if beneficial to have a lease purchase option
                 Common Audit
  • Inappropriate rates charged
  • Excessive hours
  • Project billed for non-existent equipment
  • Equipment leased from related parties
  • Equipment billed while not being utilized
  • Failure to gain possession or get credit for job
    purchased equipment
  • Cost included in base rate also charged as a direct
                 (5) Other Costs
  • Travel Related Expenses, Overhead Expenses, Field
    Office Expenses, Sales Tax
  • Audit Objectives
        – Same as Direct Labor
  • Audit Procedures
        – Review travel expenses to ensure in line with
        – Review annual overhead rates
        – Review field office expenses
        – Sales tax
                 (6) Change Orders
  • Are variations or modifications to original contract for
    any number of reasons
  • Original contract should have specific language
    regarding documentation and authorization required,
    process to price or value
  • Owner decides if change is made to contract
  • All changes should be processed by Procurement to
    ensure contract is amended accordingly
    (6) Change Orders (cont)
  • Audit Objective
        – Understand the need/justification for the
        – If change results in reduced scope, confirm owner
          received credit
        – If change requires additional work, ascertain work is
          not included in original contract
                 (6) Change Orders
                      (cont 2)
  • Audit Considerations
        – Identification of cause of change order
        – Assessment of liability-design error or omission,
          contractor performance
        – Review internal estimate of cost of change
        – Review documentation or records of negotiations
        – Excessive Change Orders
                 (7) Other Audit
  • IA should review the process established to
    assure quality management and control
        – Use of qualified sub-contractors
        – Inspection of purchased materials and equipment
        – Field verification of project work
                             Unit Nine
                 “Construction Life Cycle-Close out
  • In this module we will review some of
    the risks and exposures (receipt of all
    deliverables prior to final acceptance,
    final review of contractor billings,
    payments to sub-contractors, etc.)
    during this phase of the process and
    develop audit objectives and strategies
                 Closeout Process
  • Consists of three components
        – Physical
        – Financial
        – Administrative
                 Physical Closeout
  • First step in closeout process
  • Owner or representative determines if
    requirements met
  • Includes
        –   Testing and startup
        –   Cleanup
        –   Final punch lists
        –   Final inspection
                 Financial Closeout
  • Encompasses all monetary matters
  • Results in final payment and release of
  • Includes:
        –   Closeout audit of contractor costs
        –   Final review on contractor’s billing
        –   Confirmation sub-contractors paid
        –   Resolution of claims
        –   Satisfaction of liquidated damages
       Administrative Closeout
  • Includes receipt of all required documents,
    warranties, and training
        –   Certificate of Substantial Completion
        –   Certificate for Payment
        –   Certificate of Occupancy
        –   As-Built Drawings
        –   Operating and Maintenance Manuals
        –   Warranties
        –   Training
             Audit Considerations
  • Final review of contractor’s billings
  • Review contract and consider developing a check list to
    determine all deliverables have been received
  • Confirmation that sub-contractors have been paid
  • Confirm prime and sub-contractors have provided final
    release or waiver of lien
  • Confirm all certificates have been received, reviewed,
    and certified
  • Confirm that warranty provisions and training provided
    was consistent with requirements of contract
  • Verify that all required assets were transferred to owner
                             Unit Ten
                 “Issues Related to the Use of Sub-
  • Quite often, construction projects require the
    use of multiple sub-contractors of all sizes and
    skills. This module will address the risks
    inherent with the use of sub-contractors( sub-
    contractor approval process, common terms
    and condition with prime contractor, etc.) and
    the audit strategies to employ
  • Remember:
        – Sub-contractors engaged to perform portion of work
          not undertaken by contractor
        – Used primarily for skills and/or equipment not
          resident with General Contractor (GC)
        – GC responsible for quality of sub-contractor work
          and any delays caused by them
        – Sub-contractors employed to meet DBE contract
  • Poor sub-contractor performance
  • Related party transactions
  • Fictitious companies
  • General Contractor/Sub-contractor
    billing disputes
  • Non payment to subs by General
  • Sub-contractor approval process
  • Require pre-qualification or competitive
    bidding selection
  • Same contract terms and conditions as
    General Contractor
  • Right to audit clause
                 Audit Objectives
  • Ensure
        – Sub-contractors selected in accordance with contract
        – Sub-contractors are qualified to perform the work
        – Work performed met contract standards
        – Costs billed for sub-contractors were actually
          incurred and accurate
        – That subcontractor is not a subsidiary company or a
          related party
                 Audit Procedures
  • Assess compliance with subcontractor approval process
  • Independently verify existence of sub-contractors and
    quality of past performance
  • Reconcile payments to sub-contractors with cancelled
    checks to confirm actual payment
  • Confirm subs satisfy bond and insurance requirements
  • Conduct a cost audit of selected subcontractors
  • Review subcontractor change orders and verify basis for
  • Verify that owner was credited with subs discounts
  • confirm no outstanding billing disputes with GC
   Disadvantaged Owned
  Business Enterprise (DBE)
  • Is a for profit, small business concern
  • 51% owned by socially and
    economically disadvantaged
    individual(s) or business
  • Management and daily operations
    controlled by people who own it
                 Audit Objective
  • Ascertain firms engaged to meet
    DBE/MBE/WBE participation goals have
    met all the required criteria to be
    certified as a DBE/MBE/WBE and have
    actually performed sub-contracting
                              Unit Eleven
                 “Safety and Insurance Related Issues”
  • This module will focus on the risks and
    exposures related to a contractor’s
    safety record, insurance coverage, and
    the potential financial and reputational
    impact on construction projects
  • Can have significant negative impact on
  • Accidents happen but risk increases
    when safety is ignored
  • Contractors legally and contractually
    required to operate a safe workplace
                 Safety (cont)
  • Subcontractors should also be required
    to comply with safety aspects
  • Reminder: Past record of contractor and
    sub-contractors regarding safety should
    be a qualification for contract award
  •    Increase job costs
  •    Law suits
  •    Higher insurance premiums
  •    Project delays
  •    Lost worker productivity
  •    Property loss
  • Damages to facilities and equipment
  • Reputational damage
  •    Incorporate safety in project design
  •    Tone at the Top-workplace safety highest priority
  •    Safety program, policy statements, training
  •    Regular safety inspections and meetings
  •    Utilization of posters and warning signs
  •    Safety audits
  •    Safety recordkeeping
  •    Accident and hazardous reporting
  • Owners often require GC to purchase
    guarantee or surety bond
  • Purpose-if GC fails to finish project, funds
    available to hire replacement contractor
  • GC’s bonding capability based on financial
    statement and past performance
  • Contractor allowed to initiate
    construction prior to receipt of bonds
  • Contractor exceeds bonding capacity
  • Bonds provided by agent or broker
    rather than insurance company
                 Audit Focus
  • Verify all required bonds were in place prior to
    initiation of construction
  • Ascertain that bonds were issued by an
    approved surety bond/insurance company
  • Obtain copies of bonds as proof of existence
  • Confirm bonds remain in existence for term of
  • General condition of contract
  • Requires contractor to carry different types:
     – Could include:
        • Property insurance
        • Builder’s risk (provides coverage on
          contract works due to a fire or storm)
        • Liability (protects contractor against
          liability by public, not employees)
                 Audit Focus
  • Verify all required insurance in place
    prior to initiation of construction
  • Ascertain insurance with an approved
  • Obtain certificates of insurance
  • Confirm policy in force
                          Unit Twelve
                  “Other Audit Considerations”

    • In this unit we will discuss other areas
      for audit consideration depending on
      the size of the owner company,
      industry, etc., that may provide
      opportunities to enhance the
      governance process and construction
                 (1) Environmental
  • Variety of laws and regulations
  • Many of the required permits are for environmental
  • Owners and contractors have ethical obligation
  • Issues subject to monitoring and control
        –   Solid waste disposal
        –   Products of demolition and renovation
        –   Water drainage or discharge
        –   Air and noise pollution
  • Contaminated materials are owned
    ―cradle to grave‖
  • Fines and penalties
  • Delays-Stoppage of work
  • Law suits
  • Remediation
  • Reputation
  • Establish a program to monitor contractor
  • Conduct inspections
  • Contract to specify action regarding removal
    and disposition of waste
  • Documentation to support disposition
  • Certification hazardous materials disposed in
    required sites
                       Wrap Up
  Summary of Key Learning Objectives

  •    Why audit contracts?
  •    What should be audited?
  •    When should the audit take place?
  •    Who should be doing the review(s)?
  •    Where should it be conducted?
  •    How should it be done?

  • Course Evaluation
                  Thank you for
                 your participation!

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